Sector Overview - Private Equity

2017 saw a pronounced fall in the number of reported private equity deals by Africa-focused private equity funds, with 149 deals and 32 exits; down from over 200 deals and 41 exits in 2016. The main sector focus for private equity investments in 2017 was in consumer discretionary followed by information technology, with other sectors providing exposure to the key theme of the rise of the African consumer (such as financial services, education, healthcare and agribusiness) being considered more attractive at present by many investors than commodities and resources.

Although economic growth for the continent ticked up from 2.2% in 2016 to 3.7% in 2017, and despite the largest economies (and markets for deals) in Africa, such as Nigeria and South Africa, having exited their respective recessions during 2017, across the board, the pace of recovery remained sluggish with the decreased level of private equity activity overall reflecting the continent’s economic malaise carried over from the decline in global commodity prices over the course of 2015 and 2016, together with other challenges such as continued foreign exchange volatility and political uncertainty across a number of jurisdictions.

Interestingly, as Africa is such a large and diverse continent, while the more mature deal markets such as Nigeria and South Africa were quieter during 2017, North African markets, most notably Egypt, Morocco and Tunisia saw increased levels of activity during the same period, as the political climate in these jurisdictions continued to stabilise and governments continued to pursue reform agendas aimed at improving the business environment for foreign investors.

Some of the main challenges facing private equity investment in Africa continue to include low commodity prices, political instability and uncertainty, foreign exchange volatility and foreign currency shortages, the cyclical nature of commodity-exposed businesses, corporate governance/compliance and sourcing appropriate local partners with proven track records.

Additional challenges include the existence of generally unsophisticated private equity and transactional markets, the difficulties of deal origination, the need, generally speaking, to hold assets for longer periods, together with uncertainty regarding ease of exit, unpredictable regulatory climates and the complexity of the regulatory position where deals involve assets in different African jurisdictions. While it is certain that there is a large amount of dry powder allocated to Africa-focused investments, ready for deployment both by local and offshore fund managers who are looking to diversify their portfolios, chasing the mid-sized to large deals, there continues to be a shortage of high quality, bankable assets coming onto the market. This has led to increased levels of competition for the more attractive assets, potentially resulting in higher entry values for the larger assets, with these higher prices subsequently impacting the ability of funds to generate high returns.

Fund raising

Private equity fund raising in Africa in 2017 reached USD 2.3 billion compared to USD 3.4 billion in 2016. This slow-down in fund raising is primarily due to a number of large funds having reached their financial close in 2016. African private equity remains underrepresented within institutional portfolios and among traditional African international institutional investors such as pension funds and insurers.

This underrepresentation is viewed by private equity fund managers as a potential untapped source of additional funds for private equity investments, provided the reasons for underrepresentation can be overcome. The underrepresentation among African institutional investors may be due to a lack of understanding of the asset class and perceived higher risk, together with often restrictive regulatory regimes across a number of African jurisdictions and perceived difficulties relating to securing exits from these markets.

Typically, underrepresentation among international institutional investors is due to the more limited number of fund managers pursuing an Africa-focused strategy with a demonstrable track record of success, transaction sizes which are generally lower on average than in other markets and therefore less easy to scale, the challenges of converting dollars into local currency and hedging those exposures over long-term hold periods, together with higher levels of FX volatility and the expectation of a premium return for investing in Africa which is perceived as a riskier investment than investing in the United States, Europe or indeed, many of the other so-called emerging markets. There continues to be a perception among international institutional investors that pursuing an Africa strategy is a specialist activity.

Recently there have been promising developments in a number of African jurisdictions as governments ease restrictions and increase incentives in the hope of attracting investment.

For example, in Nigeria the threshold for minimum local investment of pension fund assets by infrastructure and private equity funds was decreased to 60% from the previous 75% threshold, thus allowing local fund managers to look for investment in other African jurisdictions in order to maximise profits. In Morocco, the reduction of corporate tax for investments in innovative start-ups and the introduction of a progressive tax rate for companies investing in small to medium-sized enterprises is likely to result in increased levels of investment.

Notwithstanding the slow-down in fund raising, a number of new Africa-focused private equity funds were established in 2017, including EXEO Capital, a pan-African private equity investment firm, which closed its second Agri-Vie Fund (Agri-Vie Fund II), focused on the food and agribusiness sector in Sub-Saharan Africa, after attracting commitments of over USD 100 million.

Adenia Partners also announced the final closing of Adenia Capital (IV) at its cap of EUR 230 million, which will target medium-size profitable companies generating turnover of between USD 5 million and USD 40 million and EBITDA (earnings before interest, tax, depreciation and amortisation) of between USD 1 million and USD 7 million. The fund seeks to invest in a variety of sectors including fast-moving consumer goods (FMCG), business services, manufacturing, fintech, telecoms and healthcare.

AfricInvest also announced FIVE’s first close. FIVE is an evergreen investment fund for investing in financial institutions in Africa for investors with the capacity to make longer term commitments and has been structured to align the interests of investors and managers, including appropriate liquidity provisions to allow investors to adjust their exposure to FIVE.

Deals

According to the African Private Equity and Venture Capital Association 2017 annual African Private Equity Deal Tracker, USD 3.8 billion was invested in 149 reported deals in Africa in 2017. Some of the notable deals concluded or announced in 2017 included the Carlyle Group’s acquisition of a significant stake in Africa’s largest credit rating agency GCR (headquartered in South Africa) from the founders and DEG through the Carlyle Sub-Saharan Africa Fund and 8 Miles’s acquisition of a minority stake in Blue Skies, a UK-incorporated business with operations in several African countries involved in the production of fresh-cut fruit and juice products for UK and Western European supermarkets.

Another noteworthy deal was LeapFrog Investments’ investment of USD 180 million in Ghanaian financial services provider Enterprise Group, funded from LeapFrog Strategic African Investments, which is a separately managed account established to access high growth markets in Africa. The investment represents LeapFrog’s largest investment to date.

Exits

Ensuring a viable exit environment which enables exits within relatively predictable timeframes is critical to the success of the private equity industry in Africa. Exits to trade buyers, particularly buyers with a regional focus, remain the most prevalent exit route for African private equity funds. We have also seen a number of secondary transactions, with one fund selling to another and initial public offerings on African stock exchanges are beginning to gain more favour, which indicates that the private equity market in Africa is both maturing and developing. We are also seeing the early signs of the introduction of certain features of private equity in the developed markets, with specialist providers of warranty and indemnity insurance solutions beginning to show some appetite for risk underwriting in respect of more mature African assets, as these risk solutions become increasingly prevalent in the European and American markets and the more specialist underwriting firms seek new categories of risk to underwrite.

Some notable exits by private equity funds in Africa in 2017 included that of Development Partners International, through its African Development Partners I (ADP I) Fund, which exited by selling its 27.7% shareholding in CAL Bank in Ghana to Arise BV, a financial services investment company whose major shareholders are Norfund, Rabobankand FMO. Another noteworthy exit was Convergence Partners Investments from specialist IT services and solutions company, Dimension Data Middle East & Africa (DiData). Convergence Partners and DiData negotiated a consensual exit to the investment.

Another exit of interest was Emerging Capital Partners’ disposal of its 90% shareholding in the Java House Group, East Africa’s leading casual dining chain, to The Abraaj Group.

Trends

Increase in entry multiples

According to the 2017 Africa Private Equity Confidence Survey prepared by Deloitte, private equity fund managers across East, West and Southern Africa are investment-ready, with funds ready for deployment and looking for opportunities to invest more during 2018. This anticipated increased competition for investments is expected to result in an increase in entry multiples over the next 12 months, most strongly in East and West Africa.

Key sectors

There was a particular increase in private equity investments in the information technology sector, which accounted for 15% of total private equity deals in 2017 as compared to 8% in 2016. With growing levels of affluence, increasing urbanisation and an emerging middle class demographic, the rise of the African consumer continues to be a key theme for investors. One notable area that this is manifesting itself is in the trend of increasing investment in private education, with Actis’ establishment of the Honoris United Universities private higher education network, which spans nine African countries, being one example. With up to 50% of Africa’s young population not having reached university age, the African private education space is likely to remain a lucrative investment target for the foreseeable future.

Innovative fund structures

In more mature private equity markets, we continue to see more creative fund structures being designed to meet and match the investment and liquidity needs of different investors from different jurisdictions with the particular capital needs of different businesses in Africa and to mitigate some of the challenges caused by foreign exchange controls in many jurisdictions. These innovations include the use of listed entities as direct investors in a fund, which allows managers to access publicly raised capital while providing indirect investors with liquidity.

Another trend is that certain private equity funds are evolving to become, or are creating, parallel asset management companies. However, there remains a strong desire among a number of investors, particularly development finance institutions and fund managers, to continue to use the traditional private equity model. It is an effective mechanism to create sustainable value in an investment over the typical 10-year life cycle of these funds in Africa and incentivises fund managers to earn carry based on their actual performance, measurable on actual realisation of fund assets.

There are a number of investment fund models that can be used and, if tailored appropriately, there is more than one way to meet and match the needs of different investors and businesses in Africa.

Closing thoughts

After a slower 2017 in Africa’s largest deal markets, albeit with improved economic growth prospects for the region underpinned by recovering commodity prices, private equity investment activity in Africa is expected to rise and remain a source of real value, particularly for those funds with sound business and professional connections, local savvy and the patience to allow their African investments the time needed to mature to their full potential.

About the author

Hogan Lovells' global private equity team advises private equity and venture capital houses through their growth cycle, including: fund formation; new money or private equity investments; financings; initial public offerings; as well as in mergers, acquisitions, strategic partnerships, or trade sale exits. We offer sound commercial advice for the full life cycle of your investment. Our team has a history of innovation, having advised on a number of cutting-edge fund projects that have become precedents for the market.